Is Lotus Horizon Holdings (HKG:6063) Using Too Much Debt?

Warren Buffett famously said, 'Volatility is far from synonymous with risk.' So it seems the smart money knows that debt - which is usually involved in bankruptcies - is a very important factor, when you assess how risky a company is. Importantly, Lotus Horizon Holdings Limited (HKG:6063) does carry debt. But the real question is whether this debt is making the company risky.

Why Does Debt Bring Risk?

Debt and other liabilities become risky for a business when it cannot easily fulfill those obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. Of course, plenty of companies use debt to fund growth, without any negative consequences. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Lotus Horizon Holdings

What Is Lotus Horizon Holdings's Net Debt?

You can click the graphic below for the historical numbers, but it shows that Lotus Horizon Holdings had HK$19.0m of debt in September 2021, down from HK$20.8m, one year before. However, it does have HK$51.7m in cash offsetting this, leading to net cash of HK$32.6m.

How Healthy Is Lotus Horizon Holdings' Balance Sheet?

According to the last reported balance sheet, Lotus Horizon Holdings had liabilities of HK$49.1m due within 12 months, and liabilities of HK$7.60m due beyond 12 months. Offsetting these obligations, it had cash of HK$51.7m as well as receivables valued at HK$124.7m due within 12 months. So it actually has HK$119.6m more liquid assets than total liabilities.

This surplus liquidity suggests that Lotus Horizon Holdings' balance sheet could take a hit just as well as Homer Simpson's head can take a punch. Having regard to this fact, we think its balance sheet is as strong as an ox. Succinctly put, Lotus Horizon Holdings boasts net cash, so it's fair to say it does not have a heavy debt load!

It is just as well that Lotus Horizon Holdings's load is not too heavy, because its EBIT was down 69% over the last year. Falling earnings (if the trend continues) could eventually make even modest debt quite risky. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Lotus Horizon Holdings will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. While Lotus Horizon Holdings has net cash on its balance sheet, it's still worth taking a look at its ability to convert earnings before interest and tax (EBIT) to free cash flow, to help us understand how quickly it is building (or eroding) that cash balance. In the last three years, Lotus Horizon Holdings created free cash flow amounting to 13% of its EBIT, an uninspiring performance. That limp level of cash conversion undermines its ability to manage and pay down debt.

Summing up

While it is always sensible to investigate a company's debt, in this case Lotus Horizon Holdings has HK$32.6m in net cash and a decent-looking balance sheet. So we are not troubled with Lotus Horizon Holdings's debt use. When analysing debt levels, the balance sheet is the obvious place to start. However, not all investment risk resides within the balance sheet - far from it. For example Lotus Horizon Holdings has 5 warning signs (and 1 which shouldn't be ignored) we think you should know about.

At the end of the day, it's often better to focus on companies that are free from net debt. You can access our special list of such companies (all with a track record of profit growth). It's free.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

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